COLLECTING ON A PAST-DUE DEBT:
THE LOUISIANA OIL AND GAS PROCESSING FEE
By Foster Campbell, Louisiana Public Service Commissioner
March 2007

Background

The State of Louisiana relies heavily on oil and gas severance taxes and mineral royalties as revenue for the State Treasury. The state receives royalty payments for production from State-owned lands and water bottoms, but receives severance-tax revenue from all oil and gas production on any property within state boundaries. The state offshore boundary extends three miles from the coastline, beyond which is federal territory. The only revenue the state receives for production in federal waters is 27 percent of the revenue for the 3-mile-wide band of water that extends from 3 miles to 6 miles from the state coastline, which is the first 3 miles of federal waters. Beyond that, the state receives no revenue from the vast production in the federal offshore area.

Unfortunately, both oil and gas production from within the borders of the state peaked in 1970. Currently, Louisiana natural-gas production is a meager 23 percent of its 1970 level, and Louisiana oil production is 14 percent of its 1970 peak. During this same period, imports of foreign oil and gas and from federal offshore waters increased dramatically.

As Louisiana’s oil and gas revenue base has eroded, large quantities of oil and gas are flooding into the state from production in federal waters (called the federal “Outer Continental Shelf,” or OCS) and foreign countries to be refined or otherwise processed. These imports provide the state no revenue to offset the loss of revenue from long-declining state production.

It is worth noting that while Louisiana taxes natural-gas production at a rate which is mid-range relative to other states, Louisiana’s severance tax on oil is the second highest after Alaska. Also, Louisiana applies reduced-rate severance taxes to marginal production at so-called “stripper wells” and “incapable wells,” as do most other states. The volume of all this production continues to decline, while volumes of untaxed federal OCS and foreign oil and gas flood the state.

A Dwindling Revenue Base vs. a Growing Revenue Base

Should Louisiana continue to rely on a revenue structure that levies a high tax on struggling in-state producers and ignores the enormous volumes of oil and gas imported into our state? Importing oil and gas from outside Louisiana relies upon the people, infrastructure, and resources of the state to process it so that the rest of the country benefits from its availability to fuel their automobiles and heat their homes and businesses.

Louisiana production is only 4.5 percent of the oil processed in the state. The remainder is 24.9 percent OCS, 12 percent imported from other states, and 58.6 percent foreign oil. For natural gas processed in the state, the source is 24.3 percent Louisiana production, 46.3 percent OCS, 27 percent imported from other states, and 2.4 percent foreign imports.

As noted, Louisiana production is shrinking and state revenue along with it, yet imports of oil and gas are on the rise. Were the state tax base to include imported oil and gas, it would be 22 times as big for oil and 4 times as big for natural gas as now. With a base that large, a much lower fee than the current Louisiana severance tax could generate much higher revenue.

A lower processing fee on this larger volume could provide a tax cut to current Louisiana oil and gas producers, and also make possible the complete elimination of the tax on marginal stripper and incapable production.

Pre-’81 data from other-state and foreign sources not available.

The Revenue Potential

The rate of the Louisiana oil severance tax on full-rate production is 12.5 percent of value. The Louisiana natural-gas severance tax is an indexed rate that changes each year based on the previous year’s average market price. The fiscal year 2007/08 natural-gas severance tax rate is 26.9 cents per MCF (thousand cubic feet), which is equivalent to 4.5 percent of value for gas at a price of $6 per MCF.

For each 1 percent of value for a processing fee on all oil and gas processed in the state, approximately $918 million could be generated in fiscal year 2008-09. A 6-percent rate would produce $5.51 billion. All Louisiana severance taxes would be repealed when the processing fee goes into effect, and the net new revenue produced by the processing fee would be $5.51 billion minus the $693 million in severance taxes estimated to be generated, for a NET NEW REVENUE of $4.82 billion. This is based on an oil price of $57 per barrel and a natural gas price of $6 per MCF.

In summary: replacing a 12.5-percent-of-value oil severance tax and a 6.2-percent-of-value natural-gas severance tax — both paid only by Louisiana producers — with a 6-percent-of-value processing fee on all oil and gas produced or processed in the state, would reduce taxes for Louisiana producers while raising $4.8 billion annually in new revenue.

Attempts to Avoid the Fee

Large national, international, and foreign oil companies import oil into Louisiana from the Middle East, Venezuela and the deep waters in the OCS. Will they divert oil or gas around the state if the processing fee is implemented? They will divert as much as they economically can, but economics and physical reality severely limit how much can be diverted. Significant diversion was assumed. The previous revenue projections are net after diversion.

Diverting oil or gas around Louisiana requires facilities (refineries matched to the particular crude-oil types, gas-processing plants, storage tank farms, etc.) that have the right equipment and spare capacity, plus transportation infrastructure (pipelines, barges, ships, railcars, ports, rivers, canals, etc.) to move it where it needs to go. All this assumes you can accomplish this diversion economically.

There are substantial limits to the availability, accessibility, and economic viability of this processing and transportation infrastructure. Little of it exists. For the above revenue projections, it is assumed that all spare processing capacity which is available for diversion will be used, up to maximum sustainable operating capacity, without regard to whether it is economic or practical to do so.

Diversion Assumptions:

Oil:

It is assumed that all refined products will be diverted. An estimated 434 million barrels of crude oil currently coming into Louisiana is assumed to be diverted. This is enough crude oil to fill up to capacity (assuming a 96-percent sustainable refinery utilization rate) every refinery in the entire eastern half of the United States, whether feasible to do so or not. Refineries beyond that range are not feasible diversion alternatives.

Natural Gas:

It is assumed that 837 billion cubic feet of natural gas currently coming into the state will be diverted. This is equivalent to about 16 percent of the gas entering Louisiana.

The United States is short of processing capacity, especially refinery capacity, and the construction of new processing capacity in other states is severely limited and would be a decades-long process. Local citizens routinely and vehemently oppose building new pipelines, refineries, and other hydrocarbon-processing facilities. Environmental constraints due to emissions limits on ozone and reactive hydrocarbons limit expansion or siting of new facilities in the few communities that would allow such development outside of Louisiana.

How a Processing Fee Would Work

A processing fee is simply a fee on the processing of oil or natural gas. The fee would apply to refined petroleum products (typically fuels) that are imported into the state and are further processed, but not to petrochemicals. As contemplated in Louisiana, the processing fee would replace the severance f and would be applied only once, at the first point of processing in the state. Further processing steps would not be subject to the fee. For Louisiana production, the first point of processing would be at the wellhead, similar to the way severance tax is applied, except at a lower rate.

Typically, hydrocarbons undergo many processing steps at field-processing facilities and other treatment equipment well before they reach a major processing facility such as a natural-gas plant or a petroleum refinery. The main exception would be situations in which foreign crude oil arrives at a refinery in a tanker that off-loads directly at the refinery.

For the application of this fee, hydrocarbon processing is defined as any process or procedure whereby a hydrocarbon or mixture of hydrocarbons, excluding petrochemicals, undergoes any one or more of the following operations:

The processing fee would be applied at the time the first processing step from the list above takes place in the state. The processing fee would be applied to hydrocarbons originating outside the state at the first point of processing within the state, and for hydrocarbons produced within the state, at their first point of processing within the state.

The Constitutional Question

Constitutional scholars have reviewed the processing fee and are confident it would withstand likely federal court challenges. The processing fee will apply equally to all oil and gas processed in Louisiana, regardless of where the oil or gas was originally produced. The activity of processing the hydrocarbons in the state establishes a significant nexus within the state. The processing fee, unlike the unconstitutional First Use Tax attempted years ago, should not violate the Supremacy clause or the Commerce clause of the U.S. Constitution.

Conclusion

Louisiana was a major oil and gas production state when the severance tax was written into the State Constitution in 1921. Today, Louisiana is primarily an oil and gas processing state. Despite this profound change in the basic nature of the industry, the State’s method of taxing oil and gas has remained virtually the same for nearly 90 years. Enacting the oil and gas processing fee — by constitutional amendment approved by the voters of Louisiana — would match the revenue base of state government to today’s oil and gas industry. This change is long overdue and much-needed.

Foster Campbell represents North Louisiana on the Public Service Commission. Charts and graphs reproduced in this paper are from the Louisiana Department of Natural Resources. For more information, call 318 676 7464 or email foster@fostercampbell.com.